Greening the Financial System: Tilting the Playing Field

Greening the financial system Tilting the playing field The role of central banks OCTOBER 2019

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Prepared by the Climate Bonds Initiative Supported by WWF and Prashant Vaze, Alan Meng, Diletta Giuliani SOAS Centre for Sustainable Finance Summary

Climate change, through physical damage to assets owned by banks and insurers and through an abrupt reduction in value of fossil fuel related assets, represents a risk to the stability of financial institutions and the financial system as a whole. Risks of climate change are long- term, rising, poorly understood and hence under-valued by the short- term metrics used by banks to evaluate financial risk. Governments have the primary responsibility for developing policy to reduce climate risks. But Central banks and financial regulators (CBFRs) can and, this paper contends, should play an important role too. CBFRs have established the Network for Greening the Financial System. The Network is being used to share research and experience on how best to manage climate risks. As regulators, lenders of last resort and monetary policy makers, CBFRs have a variety of tools to influence the lending and investment behaviour of banks and insurers. Individual CBFRs are already undertaking actions to raise the awareness of climate risks in financial institutes and apply these principles in their own operations. But they could do even more. They could help establish reporting norms, and then mandate banks and insurers to disclose their climate risks and perform climate stress tests. They could themselves tilt their own purchases of financial assets so as to buy less fossil- fuel intensive assets and more green assets. They could change the weightings applied to the regulated financial assets banks and insurers hold to better reflect long-term climate risks. In several emerging markets, where central banks play an important role in determining the allocation of credit in the economy, CBFRs could develop quotas so that financial institutions switch their lending to and investment in from brown activities to green.

Greening the Financial System Climate Bonds Initiative 2 Introduction

“4°C warming makes the Box 1: world uninsurable” Summary of recommendations from TCFD and NGFS reports Thomas Buberl, Axa CEO1 Task Force on Climate-related Financial NGFS – comprehensive report – Disclosures – June 2017 April 2019 TCFD made recommendations to G20 Recommendations to CBs: This briefing paper looks at the role central about the disclosures all organisations • Integrate climate-risks into monitoring banks and micro-prudential financial should make to their stakeholders to and supervision activities. regulators (CBFR) could play in greening facilitate the market’s understanding of the financial system. Central banks are climate related risks. • Implement them in portfolio concerned with regulating macro-economic management. • Governance: Board and managements role goals like stable inflation and output growth, in assessing and managing climate risks • Bridge data gaps availability of credit to sectors and the overall stability of the financial system. • Strategy: Where material, disclose • Supply technical assistance and share Micro-prudential regulators are more short, medium and long-term risks and knowledge within the central banking concerned with the stability and conduct of opportunities including resilience to community. individual financial institutions. This paper different climate scenarios For the policy makers and the private lumps together central banks and micro- • Risk management: How organization sector, it calls for: prudential regulators even though in many will manage climate related risks countries responsibilities are spread over • Robust and consistent disclosure of multiple organisations with the precise • Metrics and targets: Disclose the environmental risks, and; demarcation varying between countries. organisations’ direct and indirect • A taxonomy of green and brown assets. emissions and targets Section 1 provides a background of how the CBFR’s have been adopting the climate There were supplemental recommendations change risk agenda. Section 2 of the paper to the finance sector (lender, underwriter, discusses the current roles played by CBFRs investor and asset manager) of the role it and reviews the instruments in current plays in capital allocation and the leverage use (though not necessarily for ‘green’ this provides to lead best practice. purposes). Section 3 covers current policies for reducing climate risk. Section 4 talks about possible actions they could take to have committed to support the TCFD This paper frequently refers to the bond reduce climate risk. recommendations;4 though investors say market and speaks to the use of green bonds. disclosure is still insufficient with only 25% CBFR’s remit covers the entire financial The discourse around central bank action of companies reporting on five or more of system and many of the points being made has advanced markedly over the past few the 11 recommended disclosures. apply equally to other financial instruments, years. Mark Carney’s Tragedy of Horizons especially loans. That said, the bond market speech,2 given to an audience of insurers Fast forward two more years, to April 2019, is critically important: around half of all at Lloyds, marked an important point: a central banks assembled into a coalition- financial assets, roughly USD 100 trillion,7 senior central banker, the then chair of the of-the-willing, the Network for Greening are held as bonds, especially by long-term Financial Stability Board, articulated the the Financial System (NGFS), published its investors like pension funds.8 Bonds issued risks and opportunities stemming from first “comprehensive report”. It outlined six by developed market sovereigns and climate change. He spoke about the “current actions that should to be taken by central high-quality corporates, because of their and prospective financial stability risks banks, governments and industry (see Box low risk of default and liquidity, play an from climate change” and the role financial 1).5 In essence, the report suggests that important role in financial regulation. They policy-makers need to play “in ensuring the CBFRs implement climate-risk thinking are used by banks and insurers to comply financial system is made resilient to any in their own actions, provide technical with supervisors’ requirements to hold transition hastened by those decisions, and assistance to financial institutions (FIs) and High-Quality Liquid Assets to fulfil Basel that it can finance the transition efficiently.” recommend that FIs collect and disclose III’s pillar 1 requirements. This has created a His message was clear: climate change was more data to the market. Box 1 summarises situation where there is a ready market for a risk to the financial system and financial the main recommendations by the NGFS highly rated sovereign bonds even if they pay policy makers needed to act. and the TCFD. negative interest rates.9 In 2016, the influential Taskforce on Climate The securities and exchanges As prudential supervisors and monetary Related Financial Disclosures (TCFD)3 was regulators (IOSCO) have also established authorities, CBFRs have a huge impact on established by the Financial Stability Board a sustainable finance network. This the bond market, including by (a) deciding (FSB) and chaired by Michael Bloomberg. has already published a short explanatory whether or not particular bonds may serve Its 2017 report has played a significant paper.6 The network is kicking off work as collateral, (b) determining and validating role in steering the direction of the current by undertaking a stock take on current any adjustments made to allow for their debate on transparency. The most recent actions by members especially riskiness, and (c) proscribing which sorts of status report says that 785 organisations, on standards for ESG disclosures bonds to purchase for own-account reasons. of which 374 are in the financial sector, recommended by regulators.

Greening the Financial System Climate Bonds Initiative 3 What do CBFRs do and what should they do?

they can use and will effect the range of of QE first in Japan then US and Europe in “With great power comes existing skills and competencies. Their response to deflationary pressures. great responsibility.” roles in overseeing conduct, supervising, Increasingly central banks speak about investigating and remedying infractions and Uncle Ben climate change as a threat to financial complaints will occupy much of staff time, (Spiderman’s uncle) systems, framing their initiatives as a and determine the skill sets of the staff. response to the market’s under-pricing of Box 2 gives a summary of CBFR’s roles climate risk. In an open letter three central CBFRs roles include the following: and instruments. The underlined items are bankers comment:12 “…We recognise that discussed further as possible instruments to the challenges we face are unprecedented, 1. limiting inflation through setting green financial systems. urgent and analytically difficult. As long as interest rates and reserve requirements, temperatures and sea levels continue to influencing the supply of money and This means that within their current legal rise and with them climate-related financial the allocation of credit in the economy frameworks central banks’ focus is on risks, central banks, supervisors and financial (monetary policy) economic goals such as price stability, institutions will continue to raise the bar to economic growth and safe-guarding the 2. promoting financial system stability address these climate-related risks and to stability of the financial system. That said (macro-prudential regulation) “green” the financial system.” central banks have considerable latitude to 3. supervising banks and other financial be inventive in the actions taken to support In terms of concrete actions – the response institutions (micro-prudential regulation) financial stability – witness the development is still muted. Members of the NGFS are still

4. fostering payment safety and consumer protection. Box 2: These duties are often split between the Role of the central banks and financial regulators central bank and specialist sector regulators for insurance companies, pension companies, etc. Monetary policy 3. Short term liquidity = High Quality Liquid Assets/ Net Cash Outflows In addition to these primary roles, CBFRs Central banks (CB) are required to may also have responsibilities for wider maintain inflation within specified levels. 4. Longer-term liquidity (1 year) = government priorities like employment, The instruments they use include Available stable funding/Required economic growth or economic sustainability. stable funding 1. Open market operations – purchasing In a review of the mandates of 133 central / selling financial assets to stabilise Under Pillar 2 central banks require bank mandates, Dikau and Volz find that exchange rate supervised banks to stress test their 12% have specific sustainability mandates, solvency and liquidity using a standardised generally coached in terms of sustainable 2. Standing facilities to provide banks with combination of unfavourable market and growth of the economy e.g. Philippines, liquidity – using the collateral framework climate assumptions. Malaysia and Iraq and on occasion for 3. Minimum reserves – regulated banks sustainable development: Nepal - “to Other roles must hold a share of net deposits with the maintain the stability of price and balance CB (US deposit taking banks must hold CBFRs may perform other duties varying of payment for sustainable development of at least 10% of deposits with the Fed) between countries economy”. Altogether 29% are mandated to support government priorities which usually 4. Non-standard monetary policy/QE – 1. Maintaining currency peg/Managing include sustainability. While the primary purchasing of assets to counter deflation foreign reserves responsibility of central banks includes Prudential regulation 2. Investment management – e.g. staff creating and maintaining price stability, pension schemes some mandates also give equal weight CBFRs ensure banks, insurance companies to other economic objectives, including and other FIs are robust against market 3. Credit guidance sustainable growth, full employment and risks. These are internationally agreed and 4. Consumer protection through the in the case of several emerging markets (will) follow the Basel III agreement. The regulation of the conduct of banks, anchoring the exchange rate. 10 objective of the requirements is to ensure insurers, financial financial institutions have sufficient capital A hierarchy of goals is seen in the Europe reserves to ensure solvency & ready access advisers and other intermediaries System of Central Banks (ESCB): “without to cash if the market conditions change. prejudice to the objective of price stability, 5. Promotion of competition between the ESCB shall support the general 1. Eligible capital (mainly from equity and financial service providers economic policies in the Union with a view retained earnings)/(credit + market 6. Regulating exchanges to contributing to the achievement of the positions + risk weighted assets) objectives of the Union as laid down in Article 3 greater than 7% (in UK) 7. Regulating disclosures of market of the Treaty on European Union.”11 sensitive information 2. Leverage ratio = Capital measure / It is important to understand the range of Exposure measure. Both numerator and duties that are already given to central banks denominator are based on their non-risk and financial regulators since these will set weighted values the boundaries for the sorts of measures

Greening the Financial System Climate Bonds Initiative 4 in data collection mode. In the UK, the UK Equinor, collectively spent just 1.3% of Prudential Regulation Authority has issued their CAPEX on low carbon investments supervisory notes essentially asking FIs to such as renewables or CCS.14 Since the implement TCFD’s recommendations on Paris Agreement was signed in 2015 eight a voluntary basis. Such actions are useful, European banks have provided $16bn of coal requiring forward looking disclosures of finance chiefly outside Europe.15 Axa, now climate risks by FIs. But their ultimate divesting from coal, doubled its holdings in success still assumes that self-interested coal assets since the Paris Agreement was long-term investors armed with better data signed, and owns around 200 tonnes of coal will reassess their investment decisions. per mil USD AUM.16 This belief that better information will make There are legal and jurisdictional reasons market participants correctly price climate why central banks, working through capital risk more efficiently is mishearing Carney’s markets, might be better placed to mitigate more fundamental “tragedy of the horizons” global carbon emissions than governments. critique. What if investors prioritise animal National climate change policy operates spirits over the greater good? on territorial emissions as defined by the The UK PRA has gone further than other nation’s geographic boundaries and pays no central banks and announced a consultation heed to the fact that managerial control and on a climate stress test to be undertaken in financial benefits might reside elsewhere. autumn 2019, followed by introduction of EU governments’ efforts to combat climate the stress test itself in 2022. It also issued change have not sought to inhibit the climate stress test scenarios for the life production or financing of fossil assets by insurance sector, but these leave the key their oil majors or banks and insurers. Indeed, parameters for the test unspecified and for the global operations of banks and oil the firms to choose for themselves based on companies are important sources of national recommended sources.13 The three scenarios income. While European governments are a down-grading of fossil intense assets have succeeded in reducing their UN-FCCC by 2022, an orderly transition broadly in defined emissions, European oil companies line with the Paris Agreement so to achieve continue to undertake worldwide investment carbon neutrality by 2050, and a physical in new fields, and European FIs continue to risks scenario of a 4°C temperature rise by hold assets in global oil and coal. It is worth 2100. emphasising this point. Though many of the richer economies have reduced emissions Despite numerous speeches and reports within their territories, they continue to reap about the under-pricing of climate risks the income streams by being the beneficial by FIs, CBs have not so far applied their owners of assets. Put bluntly they have off- powers from prudential regulation or shored their carbon emissions to the rest of monetary policy to oblige FIs to reduce the world. climate risk exposure. FIs remain free to lend to, underwrite, or acquire assets even But the OECD economies remain exposed, if regulators fear they are mispriced. CBFRs via the finance sector, to physical and argue democratically elected governments transition risks. In theory, CBFRs should need to take the lead, using instruments like be concerned with the balance sheets carbon pricing to reign in carbon emissions of banks and insurance companies they reductions. supervise no matter where their assets are located. This means they are well placed to But Governments have so far failed to think internationally across the world’s capital decisively tackle emissions. Despite 30 markets. In reality central banks will be years of climate policy, global emissions answerable to their governors and national are still rising. Government’s difficulty in finance ministries. The days of the Governor creating and maintaining an effective policy of the Bank of England intimidating UK banks is evidenced by the EU-Emission Trading with the might of his eyebrow are probably Scheme’s (ETS) major shortcomings. This, over, but central banks are more powerful the world’s largest carbon market, has seen than energy and environment ministries, and the price of carbon fluctuate from a peak of better equipped to undertake the complex €30/tCO in June 2009, to a nadir of €3/ 2 modelling of risks and benefits than other tCO in April 2013, and back to €27/tCO in 2 2 public institutions. Uniquely for public April 2019, as a result of EU policies aiming bodies they are outside the normal political to remove the oversupply of credits from process and have independent boards that Phase III of the EU-ETS. make publicly published decisions and are The volatility of carbon price has deterred led by governors whose job tenures extend the “brown to green” shift in investment much longer than many politicians. activity. In 2018, the oil and gas majors, including European companies like BP and

Greening the Financial System Climate Bonds Initiative 5 Using CBFR’s toolkit for reducing climate risk and greening the financial system

CBFR’s have a wide array of instruments Figure 1:Toolkit of policies at central banks disposal to change FI behaviour. Figure 1 sets out a selection of instruments that CBFR’s could Regulating Green and Mandating Standard Climate repurpose to help the financial system aid transparency brown climate climate stress tests the transition to a climate change friendly taxonomies disclosures scenarios economy. These are discussed further below.

Financial asset Non- Staff pension Currency Regulating purchase by conventional funds stabilisation transparency central bank monetary pol. funds Green and brown taxonomies Financial Capital Collateral An organisation’s exposure to climate risk asset adequacy framework depends on the carbon-dependency, location weightings and physical resilience of their assets. Since “brown” assets, like oil refineries or coal mines are tied to fossil fuel use, they risk Credit Lending Interest rate Green bond becoming stranded if global carbon prices guidance & quotas discounts incentives discourage fossil fuel use. Similarly, if assets incentives are located in areas vulnerable to climate change then worsening climatic conditions make the assets less insurable. “Green” nor “green” and can be used with sustainable by the High-Level Expert Group.17,18 The assets like renewable energy facilities or or non-sustainably sourced energy. TEG published their report on the “green” highly energy efficient buildings mitigate taxonomy in June 2019. An agreed definition GHG emissions and are resilient to climate In China the People’s Bank of China (PBOC) of “green” economic activities gives change. “Brown” assets give rise to GHG has developed the green catalogue. In investors wishing to invest in sustainable emissions or are vulnerable to worsening Europe, the European Commission has economic activities protection against false climate conditions. There are many assets, tasked the Technical Expert Group on greenwashing claims. But the European for instance railways, transmission and Sustainable Finance (TEG) to advise it on the Parliament shied away from the original distribution grids that are neither “brown” definition of green assets as recommended proposals on also defining brown assets.19

Taxonomies could be an important component in creating a widely accepted and standardised climate credit risk assessment. Indeed the NGFS report called for an understanding of the risk differentials between green & non-green and brown & non-brown assets.20 These can be used as the basis for banks to “tag” individual loans and assets according to whether they are green, brown or neutral, in much the same way that a loan for a mortgage will have information about the loan-to-value ratio. This data is later used at the portfolio level to 2 CO o risk adjust the overall value of the mortgage 2 book. Tagged assets can be traced through the balance sheets of intermediaries, asset managers and the end investors.

Why should CBFRs, not governments, develop brown taxonomies?

CBFRs are tasked with safeguarding financial stability, in this capacity they are primarily concerned with brown assets since these directly embody the aforementioned climate risks to the financial system. The Governor of the Banque de France has called for brown penalising factors and noted “13% of French banks’ total net credit exposure is to sectors vulnerable to transition risks”.21 Indeed,

Greening the Financial System Climate Bonds Initiative 6 considering what role CBFRs should play to climate scenarios (a 2˚C and 4˚C world in the NGFS’s work stream on supervision assist FIs. The debate is whether rules should 2020s and 2040s) and at the impact on FIs’ advocates: “Considering the extent to which be prescriptive and give precise guidelines agriculture, energy and real estate sector a financial risk differential exists between about how forward-looking assessments portfolios. In May 2019, UNEP-FI and 20 ‘green’ and ‘brown’ assets”. Figure 1:Toolkit of policies at central banks disposal be performed, for instance specifying the institutional investors published a major CRFR’s will be sensitive to the ensure they trajectories of future carbon prices or the report with comprehensive investor guidance have appropriate scientific expertise to severity of climate impacts at different to help assess climate risks for investors and create the classification and ensure that it points in the future, or whether FIs develop align with the TCFD recommendations. It evolves keeping abreast of the scientific and their own scenarios. Central banks also need finds that investors face as much as 13.16% technical progress in the different sectors. to provide guidance on how to analyse longer of risk from the required transition to a term scenarios (10-15 years into future) low-carbon economy (using the IPCC 1.5°C CBFRs can provide the market with definitions which are inevitably more speculative but scenario); the report refers to 18 providers of and eligibility criteria for brown assets to help need a set of assumptions on growth and low physical and transition risk assessment tools identify assets posing systemic risks to FI by discount rates to ensure that the longer-term for investment portfolios.28 extending existing green taxonomies such as interests of society are being considered. those being developed in Europe and China to The three European Supervisory Authorities, Perhaps a two-tier system be used analysing include brown thresholds or criteria. through the ‘ESAs package’, have been the balance sheets on conventional time required early 2019 to develop “common Mandatory climate disclosures, scenario frames (3-5 years) and long-term time methodologies for assessing the effect of tests and stress tests frames (10-15 years). environmental risks on the financial stability of The TCFD recommends that FIs like The Dutch Central Bank (DNB) has published institutions” and to put in place a monitoring investors, banks and insurers establish a paper on the transition risk24 based on system to assess material ESG-related governance, strategic and analytic processes a macro-economic modelling of a carbon risks, taking into account the COP 21 Paris to provide forward-looking, decision- price shock. It also undertook a survey25 of agreement. useful information for their own boards major banks, insurers and pension funds and external audiences. Several CBFRs and There is no need to wait for these scenarios asking about their exposure to fossil fuel the NGFS as a body, have signalled their to be perfectly aligned to climate science. producers. Pension funds had a 5% exposure intention to initially encourage, and in the Economic stress tests are currently to fossil fuel companies mainly in the form future mandate such disclosures.22 Basel performed to assess FIs’ vulnerability to of commodities, equities and bonds. Banks’ II’s Pillar 2 also asks supervisors to evaluate representative synchronised shocks. The exposure was 2% almost all in the form of whether banks’ capital requirements are Bank of England’s stress test of UK’s seven loans. Banks’ exposure was short term: 68% adequate for their activities and risk profiles. largest banks and building societies, for less than a year, a further 23% between 1 instance, specifies several parameters Mandatory disclosures by FIs are required and 5 years before the loan was refinanced. including: “30% depreciation of GBP to in Brazil and France. In Brazil, the banking The duration of banks’ exposure to risks USD”.29 This is in no way a forecast – it is an association, FEBRABAN, adopted voluntary through lending to brown projects are far assumption used to assess the resilience of Green Protocols in 2008. In 2014, the shorter than the useful life of the underlying the FI to assure the regulator that the FIs are Central Bank of Brazil (BCB) published a physical assets. This might protect shield making adequate provision against the risk. mandatory Resolution 4,327 on Social and individual FIs – their own liability to the risk Environmental Responsibility for Financial of stranded assets end as soon their financial CBFRs are already drawing on IPCC data but Institutions23 as part of their Internal Capital position unwinds – but the economic risk of they might consider formally working with Adequacy Assessment Program (ICAAP). the stranding still lies dormant somewhere in relevant IPCC working groups, in designing the It forms part of the Basel III pillar 2 risk the financial system – either with long term data collection and scenarios needed for FIs to assessment framework and increasing investors, the oil company (and ultimately its use and share with their borrowers. the capital charge for the bank if it cannot shareholders), or perhaps with the tax-payer demonstrate adequate capacity to manage if the magnitude of disruption requires a environmental risks. future bail-out. The longer-term analysis of risks, perhaps a top-down analysis by central In 2015, France adopted the “energy banks, needs to look at the system wide transition for green growth” law. Article risks, and not the risks to individual FIs who 173 of this text is devoted to improving might have only short duration exposures. transparency on the part of investors, predating TCFD’s recommendations for But what is needed is a more granular disclosure of decision relevant information analysis of how individual FIs would be on climate change risks on financial impacted based on a portfolio level analysis markets. In the EU, the Capital Requirement of their assets. Two preliminary analyses Regulation requires banks to publish their were piloted by 16 European banks with ESG-related financial risks as from 2022. UNEP-FI on the physical risk26 and transition risks and opportunities.27 These highlight Forward looking exercises depend on the need for a co-ordinated enhancement organisations making assumptions about in the underlying data about the assets future mitigation policy and climate being financed (their location, and other impacts. To make these disclosures useful to physical attributes) held by FIs especially regulators and stakeholders, scenarios and with regards to their exposure to climate stress tests need to repeatable, systematic, risks. The physical risks looked at two and consistent. NGFS’s work-stream 2 is

Greening the Financial System Climate Bonds Initiative 7 fitness for the low carbon economy. QE has programmes are directly creating new green Financial asset ostensibly sought to make market neutral assets and policies by CBs that reduce the purchases by central purchases gradually acquiring assets cost of finance could increase the size of the through the secondary market (monetary programmes. bank financing by ESCB institutions is prohibited) The recent speech from Lagarde, the new Central banks are major purchasers of bonds to avoid dominating or tilting the market. head of the ECB, stating that the ECB should and equities. They are acquired for purposes But through their steady and persisting ‘gradually eliminate’ carbon assets and prefer like non-conventional monetary policy, demand they are actually lowering the cost green bonds, will accelerate the discussion.33 reserve management and exchange rate of capital for incumbents, in contradiction to targeting. The current practice varies between the government’s emissions targets.32 This Central banks could reconsider their asset different uses and CBFRs, but in general discriminates against new business models purchasing from FIs that lend to green the preference is to use ‘market neutrality’ and smaller companies that could play an projects and should reconsider rules that principles to decide what assets to buy. important part in decarbonising our economy. prohibit purchases from the primary markets. Concepts like market neutrality should not The EU Technical Expert Group Central banks could explore options automatically trump policy considerations recommended that CBFRs consider like setting aside credit ratings agencies like reducing the cost of the green transition. promoting greening the financial system assessments. These do not yet properly by expressing and implementing a incorporate long-term climate risk into their Currency reserve management preference for EU Green Bonds (i.e. green assessments and are focussed just three Central banks hold foreign currency bonds consistent with the EU Green Bond years ahead on credit risks of individual assets for short term management of Standard) when purchasing green bonds. issuers. Allowance if not made of the system trade imbalances, or to fund currency wide risk that fossil fuel issuers would management mandates. For instance, the Non-conventional monetary policy experience en masse if lack of progress in the Hong Kong Monetary Authority (HKMA) is Non-conventional monetary policy (QE) brown to green transition triggers a robust responsible for pegging the HKD exchange has resulted in vast purchases of assets by public policy response against emissions. rate to USD. It maintains a foreign currency monetary authorities. The Eurosystem’s (the The authors of the LSE paper are wary about reserve fund of liquid assets (the Exchange ECB and Eurozone countries’ central banks) central banks increasing their purchases of Fund). These are currently valued at USD Asset Purchasing Programme (APP) has green bonds because of the still small scale 440bn34 some 125% of Hong Kong’s GDP. bought over €2.6tr of securities.30 This vast of the European green bond market. They As the manager of the Exchange Fund, the holding represents over 10% of the Eurozone argue substantial purchases might cause a HKMA has recently announced a set of countries’ combined GDP. Purchases under mispricing in this nascent market. They do measures to support and promote Hong the APP include government bonds (around however see merit in the purchase of bonds Kong’s green finance development: a €2.2tr of purchases) and €300bn of high- from public development agencies like the EIB principle that priority can be given to Green quality corporate bonds, covered bonds and and removing prohibitions from purchasing and ESG investments if the long term return asset backed securities (ABS). Even though off the primary market. Programmes like is comparable to other investments on a risk- the programme has now stopped acquiring KfW’s funding for green building renovation adjusted basis ; an increase of the Exchange new net assets it will continue purchasing projects, or EIB’s green financing and lending Fund’s green bond portfolio; participation in assets to replenish redemptions.

The APP has purchased €18bn green bonds (€6bn corporate and €12bn public sector31) which accounts for less than 1% of APP purchases. The tight eligibility criteria set by ECB restrict asset selection to secondary market purchases of highly rated, and highly liquid bonds. With the rise of sovereign green GREEN BOND bonds starting in late 2016 the proportion of green bonds purchased is likely to rise. The EUR4.5bn sovereign issuance from o Belgium, saw a high share of central banks in the deal: 26%, compared to only 20% for a comparable deal in January. By 2016, 2 the Bank of England, which is outside the Eurozone, purchased £435 billion of assets through its QE programme. However, it does not publish data showing the magnitude of green bond purchases.

QE by the Bank of England and ECB targets high quality, liquid assets. The universe of assets allowed by their criteria favour incumbent fossil fuel business issuances which have many decades of history in issuance in debt capital markets. Their strong balance sheets are based on their historic performance which may not be a good indicator of their

Greening the Financial System Climate Bonds Initiative 8 ESG-themed public equities investments.35 However, the HKMA could make even more ambitious use of its vast reserves. Looking at Norway’s Sovereign Wealth Fund (SWF),36 the HKMA could for instance establish an exclusion list with environmental criteria.37 HKMA itself could inspire China, which – with the world’s largest foreign exchange reserves – holds USD 3tr of assets. Central banks could explore including green hard currency assets in their reserve POLLUTER management policy. Perhaps only a proportion of the reserves CO2 need to be highly liquid to defend the currency. Bangladesh Bank became the first central bank to announce they would target some of their reserves for green bond investment in October 2015.

Pension schemes managed by Central Banks Central banks may manage their staff pension schemes, and sometimes the pensions funds of a wider population (the national civil service). These are often managed conservatively focussing on government bonds. Central banks could make long-term purchases of assets that will contribute to reducing carbon emissions and be better adapted to physical risks. Overall FIs are incentivised to hold assets There are examples of central banks Financial assets like residential property loans with low assigning their staff pension schemes with loan-to-value (LTV) ratios and sovereign and ethical mandates. The Banque de France’s weightings corporate bonds with good credit ratings. pension fund has €20bn of assets and its Central banks require banks and insurance These assets use up far less ‘regulatory responsible investment charter excludes companies to hold reserves (capital capital’.42 For instance, debt issued by a coal.38 ECB has delegated proxy voting adequacy and liquidity tests) to ensure FIs “AAA” rated corporation has a risk weighting for equity investments to asset managers can sustain losses triggered by financial of 10%, a below “BB” rated company has a that have signed up to the Principles for shocks and ensure the stability of system risk weight of 150% discouraging FIs from Responsible Investment (PRI), requiring as a whole. CBFRs set weights / haircuts holding such bonds. Mortgage weights have them to incorporate ESG factors in their for the different classes of assets to reflect been made more granular: residential lending voting policies.39 The Bank of Italy recently the probability that the realised value, in the with an LTV ratio of less than 50% (i.e. the announced its intention to purchase €8bn event of a forced sale, will be lower than their home-owner has a 50% equity stake) has a of green assets of which around €1bn will be face value. The requirements are described weighting of 20%, but a 100% mortgage has green bonds. This is motivated by the desire briefly in Box 2 (page 4). a risk weight of 50%.43 for banks to reward companies taking action CBs provide large banks liquidity against on climate change. These risk weights are calculated using collateral, and act as lender of last resort as backward looking assessments of default risk The Norges Bank Investment Management – part of their monetary policy operations to that take no account of long-term climate technically a unit of the Norges Bank - but in set risk-free interest rates. The time frame risks. The chances of widespread mortgage reality, a sovereign wealth fund, goes much over which the liquidity is provided ranges default following a major climatic event further. It manages the Government Pension from within the day to three months. rendering an area temporarily uninhabitable Fund Global investing government earnings Capital adequacy and liquidity would be materially increased despite the from exploiting the country’s oil reserve. Capital adequacy rules ensure FIs hold impeccable credit history no matter that the The fund is currently valued at NOK9tr sufficient loss-absorbing capital (shareholder homes have a low loan to value ratios. (USD 1.1tr) making it one of the world’s equity and retained earnings) to finance any biggest asset managers. The management Basel III also sets one-month liquidity rules losses arising from adverse adjustments to FIs’ mandate is set by the Ministry of Finance to ensure FIs have sufficient High-Quality assets (e.g. loans, mortgages, bonds and other and incorporates ESG principles. This Liquid Assets (like cash and highly liquid asset classes e.g. property). Under Basel III loss includes a list of companies excluded or bonds). The purpose of this provision in the absorbing capital rules are being made more under observation for ethical reasons. This Basel III accord is to identify easily realised stringent, the risk weights for different assets list includes firms producing coal, causing sources of cash. were made more granular and the accord severe environmental damage, human rights standardises the approach to a greater degree For both the capital adequacy and the violations, tobacco, nuclear weapons.40 with tables detailing weighting factors.41 liquidity assessment, labelled green assets

Greening the Financial System Climate Bonds Initiative 9 (covered bonds, sovereign bonds) can be risk models being used. CBs make use Credit guidance included within the asset being assessed but of ratings agency scores where they are Though no longer fashionable in developed at present they are not separately identified. available. economies, several developing economies still Different asset classes could be segmented use credit guidance policies to direct private At its peak in 2012 around €1.2tr of assets to identify green and brown loans and bonds banks to fund specific sectors of the economy. were pledged as collateral to the ESCBs47 allowing these to be separately monitored. The Reserve Bank of India (RBI) makes use of which represents around 10% of banks’ priority sector lending (PSL) quotas to direct The People’s Bank of China (PBoC) has eligible collateral. The most important 40% of bank lending to target sectors of the included consideration of green credit in assets included covered bank bonds, asset economy.50 At present these priority sectors its Macro Prudential Assessment (MPA), a backed securities and credit claims each include agriculture (18%), micro-enterprises scoring system that assesses banks’ capital representing a quarter of pledged assets. (8%), weaker sections of the community levels and monitors risks. The greater the The preponderance of mortgage and loan (10%). The 4% balance of the PSL quota amount of green assets a bank holds, the products used as collateral reflects the must be spent on a group of different uses higher the score it receives in the MPA. balance sheets of banks i.e. the sorts of which include renewable energy and several Green credit accounts for around 9% of total assets they hold. other uses, like housing, social infrastructure outstanding loans. According to a survey In its first progress report, the NGFS and exports. This stipulation applies to all conducted by China Banking Regulatory highlighted that “climate- or environmental- domestic banks, and also foreign banks with Commission, the green loans outstanding related criteria are not yet sufficiently more than 20 branches. A criticism by banks is from 21 major domestic banks reached CNY accounted for in internal credit assessments that it increases the general cost of finance in 8.22 trillion (USD 1.2 trillion) by 2018.44 or in…credit agencies’ models which many India, forcing commercially viable customers Even within Europe, there is a precedent Central Banks rely on for their operations”. to cross-subsidise priority lending customers for support factors to be used to remedy and increasing the overall operational costs Collateral policy may have an impact on socially undesirable outcomes in the way FIs since they either must open branches in rural the asset portfolios held by commercial allocate capital. In 2003 the EU Commission areas or purchase PSL obligation certificates banks (and other central bank introduced a SME support factor for loans of originated by other institutions with larger counterparties), as banks may prefer less than €1.5mil made to SMEs to counter footprints in the rural community. to hold more assets that are favourably the tendency of banks to underserve SMEs. treated as collateral. Therefore, it can With a targeted refinancing line, Bangladesh A ‘green supporting factor’, modelled on encourage more bank financing through Bank51 (BB) allows commercial banks to the European SME supporting factor, to green bonds lending to priority sectors in refund themselves at reduced interest rates lower capital risk requirements for green the economy. The PBoC already includes for loans given to priority segments of the assets and ‘brown penalising factors’ was green bonds in their collateral frameworks economy. In contrast to outright subsidies, in the EU Commission’s action plan of and give lending priority to banks holding they rely on the private sector as a gatekeeper sustainable finance issued in March 201845 green bonds. If other central banks in the allocation of capital. The default risk and supported by the French Banking followed suit this could incentivise banks remains with the banking sector. BB recently Association. But this proposal has been to hold more green bonds on their balance announced a Green Transformation Fund of criticised by many central bankers for sheets, encouraging more bank financing USD200mil for the export-oriented textile undermining the risk-assessed basis of for low carbon sectors. and leather sectors to set up environment capital requirement regimes, since evidence friendly infrastructures.52 Banks can borrow does not support green assets as having a PBoC accepts lower rated (AA, AA+) green from BB at LIBOR+2.5% and are expected to lower level of default. bonds and green loans as collateral for its re-lend with a margin of between 1.00 and Medium-Term Lending Facility (MLF). The In the review of the EU Capital Requirement 2.5% of the cost of borrowing. The tenor of MLF offers three, six and 12-month loans Regulation, the European Banking Authority the loans would 5 to 10 years. to commercial lenders with the aim of also has been tasked to publish in two years a guiding credit to underserved sectors. This is In addition, in 2016 BB announced that every study on “whether a dedicated prudential part of a broader strategy aiming to increase financial institution was obliged to allocate at treatment of assets exposed to activities support for smaller firms, agriculture, and least 5% of their loan portfolio to green finance. associated substantially with environmental and the green economy and to help “alleviate the / or social objectives, in the form of different shortage of highly-rated corporate bonds in capital charges, would be justified from a some financial institutions”.48 Monetary Authority of prudential perspective”. Singapore’s Green Bond Green bond subsidies Collateral framework Grant Scheme To stimulate green bond issuances and Central banks lend money to banks but encourage good practices such as external Qualifying issuances will be able require collateral of marketable financial reviews of the bond’s environmental credentials, to offset 100% of the expenses for securities like bonds and non-tradable central banks could provide financial support to obtaining an external review for green assets. These are termed ‘eligible assets’.46 first time issuers and cover the associated extra bonds, up to a cap of SGD 100,000 This creation of credit allows the central costs of labelling the bond as green. (USD 71,450) per issuance. bank to expand or contract the supply of money in the economy and set the For example, the Monetary Authority of Qualifying bonds can be denominated in bank rate of interest, so is a vital part of Singapore49 has announced a Green Bond any currency but must: monetary policy. Central banks assign and Grant Scheme to cover the additional costs • be issued and listed in Singapore adjust haircuts to selectively downgrade the of going green for issuers. The HKMA has value of some assets accepted as collateral a similar programme for compensating • have a minimum size of S$200 million to reflect their perceived view of riskiness. issuers the incremental costs of green bond • have a tenure of at least three years. The haircuts to collateral reflect the credit issuance, like the verifier costs.

Greening the Financial System Climate Bonds Initiative 10 What should central banks and financial regulators do?

throughout the economy, they are different financial crisis has been more successful “It is also part of our to other sector-level threats. We do not have than governments faltering efforts to create mandate for monetary policy a historical data to guide us, left unattended a unified carbon market. because climate change the costs of inaction will rise, and there is a CBFRs could consider acting alongside affects price evolutions, high chance of contagion between regions as governments, analysing and then acting on affects the economic a sudden fall in fossil fuel price will quickly the continued under-pricing of carbon risks outlook…This is one of the be transmitted through energy markets, and through the world economy. most difficult shocks we cannot be reduced by diversification. central bankers have to deal Existing prudential regulation tools Using their regulatory toolkits to require with.” were strengthened by Basel III, allowing the finance sector to adjust could be a supervisors to better identify risky Francois Villeroy de Galhau, powerful agent for change55 alongside behaviours (lending to mortgages with ECB Board member, speech efforts by government. The finance sector high LTVs, varying assumptions in risk to Amundi annual conference, in more advanced countries is facilitating assessment models and increasing the June 2019 the continued investment in brown assets holding of inadequate loss-taking capital). (e.g. organising large syndicated loans to The tightening of the rule book now fund continued oil exploration) in developing emphasises the holding of liquid and high- In a survey of central banks, 64% of countries thereby circumventing Paris quality capital and increasing the amount respondents said that climate change is Agreement targets in investors’ home of loss-taking capital. These were tailored being handled as “a concern we are closely economies. Conventional credit risk models to solve the causes of the global financial monitoring”, but 27% of respondents also used by banks exacerbate the issue raising crisis. But liquidity and capital buffers are considered it an issue “that other institutions the cost of finance for fledgling, capital no defence against system-wide risks like should be concerned about”.53 Questions intensive low-carbon businesses impeding a sudden change in sentiment causing a were asked about the reserve purchases the roll-out of green technologies. A more repricing (“Minsky moment“) of carbon by the central banks: 69% said “there were assets which will impact on large swathes of societal benefits from reserve managers the economy taking green credentials into account when deciding asset allocation”. However A second problem is that current just 26% of central banks use ESG factors interventions that maintain ‘market neutral’ when managing their reserves themselves, asset purchasing either for QE or reserve a mere 6% asked “commercial banks to management are themselves distorting, disclose their climate related risks”. Only propping up older well-established fossil fuel one respondent currently includes climate- intensive companies and current maturity related risks in their stress tests. On a more distributions locking in old business models promising note: 59% of the respondents said and impatient investment. It is important they are considering or already looking at that any package of recommendations bring including climate-related scenarios in stress forward a perspective cognisant of future testing. generations interests to overcome the tragedy of the horizon. More generally, CBFRs recognise the potential impact of climate risks on the far-sighted risk assessment would view A number of commentators have proposed financial sector. But they believe “the prime low carbon solutions more favourably. policy changes to affect the way central responsibility for climate policy will continue Also, because of the international nature banks manage the risks from climate to sit with governments”.54 Within the of capital flows, it is difficult at a global change.56, 57, 58 & 59 Below we add our own NGFS, what CBFRs’ precise role should be level, for governments to restrict the flow suggestions to emphasise the most urgent is still being debated. The NGFS agrees that of investment into new brown assets changes that we believe should be made. CBFRs should ask FIs to better disclose their even though governments have signed These are drawn from the case studies climate risks and present them in a format international agreements like the Paris describing tools already used by CBFRs. that stakeholders can readily digest and Agreement that imply such investments are strategic decision-makers within the FIs can unnecessary and dangerous. The absence of act upon. But this is simply asking banks to effective and credible carbon markets after act at their own behest. CBs do not yet agree so many decades of discussion illustrates they should help resolve these issues using the limits to what politics and treaties can their regulatory toolkits. achieve.

We would contend that they should. The In this note we have suggested the sorts risks posed by climate change are different of actions already being used by CBFRs to other ESG matters in two important ways. which could be applied to reducing potential First is the issue of the tragedy of the horizon. climate risk exposures. The roll-out of QE Short-term benefits accruing to financial across USA, Eurozone and UK has shown players are creating long-term threats which that central banks are able to develop, co- are transferred to society. Because they ordinate and implement powerful new policy are non-cyclical, increasing and pervasive tools. Arguably the reaction to the global

Greening the Financial System Climate Bonds Initiative 11 Recommendations

Market infrastructure Policy measures to stimulate green investment When?

1. Define a brown taxonomy: EU’s and Market Infrastructure short-term Chinese governments are taking action to create a green taxonomy to support 1. Define a brown taxonomy and guide on its usage increased green lending and reduce the Decision useful transparency scope for green-washing. CBFRs are arguably more interested than governments in an 2. Mandate FIs to disclose climate risks immediately accurate understanding of climate risk. 3. Climate scenarios and stress tests short and medium-term Unlike the green taxonomy the brown taxonomy will not be ‘voluntary’ assignment Prudential in which an issuer selects to apply for a 4. Adjust risk weightings for capital adequacy medium-term green certification, but an involuntary one in which a FI has to assign a loan as brown, 5. Adjust High Quality Liquid Assets haircuts medium-term possibly despite the issuer’s protestations. Monetary As the prudential regulator they are the main customers of a brown taxonomy so as 6. Brown penalties and offsetting green support factors for medium-term to properly identify climate risks on banks’ collateral framework and insurers’ balance sheets. Defining a 7. Align APP with ESG objectives medium-term standard for brown assets (fossil fuel assets, equipment using and inputs into fossil fuels, Other functions assets highly vulnerable to physical risks 8. Green reserve management & pension funds short-term from climate) would provide the building blocks for better climate risk disclosures. 9. Central banks that already use credit guidance tools short-term They should provide guidance on how should extend them to include green lending the taxonomy is used by FIs to adjust the reported value of their assets.

The definition of a brown taxonomy has 3. Climate scenarios and stress tests: The risks. Similar adjustments could be made proved to be highly political. Businesses TCFD suggests the disclosure of climate-risk under Solvency II for insurance companies in the ‘brown’ economy have successfully, data should inform organisations’ boards and that operate in the EU. through the European Parliament, stopped their strategies. CBFDs can help stimulate 5. Adjust high-quality liquidity assets the EU Commission developing such a the process by developing a set of test haircuts: Adjustments valuing high-quality taxonomy. Governments depending on scenarios consistent with advice provided by liquid assets perhaps increasing the quality their endowments of fossil fuels deposits bodies like IPCC or national environmental requirement for brown assets 1-2 notches may take different views of whether say protection agencies on future mitigation but loosening the liquidity or credit quality gas infrastructure is brown or a transition pathways and climate impacts to stress requirement for green assets to allow them solution. Mark Carney has argued “a test capital adequacy under Pillar two of into the eligible universe. Central banks richer taxonomy that does not take a the Basel III. While a small set of reference are understandably reluctant to reduce the binary approach is needed” and is calling scenarios (including a 1.5°C scenario) should overall stringency of the capital adequacy for different shades of green. We believe be defined to ensure comparability, FIs and liquidity tests, and the reweighting such a brown taxonomy is necessary, and should be free to add their own scenarios should be undertaken to ensure there is no international working groups of regulators and explain the rationale for their inclusion. overall, deterioration in the bank balance like NGFS better able to weigh up the sheet quality when the brown and green evidence of what sectors to include and Greening prudential regulation adjustments are jointly applied. exclude. Potentially this could be led by a 4. Adjust risk-weightings for capital ‘coalition of the willing’ grouping of CBs like adequacy tests: Basel III’s Pillar 1 capital Greening monetary policy the European System of Central Banks could adequacy rules cannot be changed without seek to understand the brown taxonomies. 6. Applying a brown penalising factor in extensive international consultation, and the collateral framework: Central banks the need for substantial financial evidence. Decision useful transparency could review the haircut applied to brown However, under Pillar 2 stress tests the assets used in forward looking stress tests. 2. Mandate FIs to disclose climate risks: capital adequacy rules could be subjected to This would mean larger haircuts for brown Requiring banks to disclose their exposures climate stress tests where holdings of green assets (loans and debt instruments) offered to climate risk as recommended by the and brown assets would perform differently. as collateral. This means that banks that TCFD. Ideally this understanding of risk Our proposal is that CBFRs use brown and use loans (or bonds) with underlying assets should be built bottom-up, from assets in the green taxonomies and the results from stress which are vulnerable to physical climate and real economy, to the balance sheets of the tests to set differential weights used for risk- transition risks, would have a higher haircut. organisations that borrow and issue, through weighted asset assessments. This is a major to FIs’ balance sheets. Use would be made of 7. Offsetting green supporting factors change requiring the risk weights to use the above taxonomy to undertake a portfolio FIs would be allowed to offset, but not forward looking scenario models to augment analysis using individual loan/bond level exceed, the aggregate value of the increased the existing methodology to assess historical data for each asset on FIs’ books. haircut from their brown assets by using

Greening the Financial System Climate Bonds Initiative 12 green assets (green loans and green debt Other central bank functions instruments) which have a lower haircut. 9. Greening reserve management and CB Our proposed change would ensure that pension schemes: CBs preference for assets the overall collateral framework was no purchased for reserve management is for less stringent than now, but banks were high quality assets that are highly liquid. incentivised to lend to more climate resilient This is true even for authorities like HKMA and high energy efficiency properties. or ECB that hold vast pools of assets for 8. Green QE: Quantitative easing (QE) very long periods of time where liquidity, could contribute to the structural and “quality” should be assessed on forward transition to a low carbon economy by looking scenario assessment. The same logic injecting money into targeted sectors discussed for QE could be applied for reserve such as renewable energy and low carbon management and CB pension schemes too. transport and shunning brown assets, while 10. Credit guidance: CBFR setting explicit simultaneously fulfilling its primary aim of targets or discounts to interest rates to guide stimulating the economy.12 At the moment bank lending to preferred sectors has fallen there are often insufficient issuances of out of favour in most OECD countries. Such qualifying green bonds, but pre-announcing mechanisms could be used to guide green the intention to include these additional investment, where central banks still perform criteria would incentivise issuers to such a role, for instance in India (Priority identify suitable assets, and to originate Sector Lending targets) or Bangladesh. new green loans that could be refinanced through green bonds. To achieve this, central banks would purchase green assets, like green asset-backed securities from commercial banks. These would specify climate resilience and energy efficiency in the underlying loan pool perhaps starting with the housing markets in countries with high quality data on climate physical risks. Conversely properties that are vulnerable to climate risks and bonds from firms exposed to transition risks would be negatively screened. Such criteria enhanced quality criteria in a targeted manner for qualifying green assets. This would redress this systematic bias and help expand credit to these sectors.

The idea here would be to relax the credit requirements for green assets perhaps by one or two notches and increase those for brown assets. This would broaden the universe of assets being purchased for QE replenishment, and also stimulate the issuance of more green debt instruments (and indirectly of green loans), and with a greater variety of tenors. This could be viewed as a move away from the market neutrality principle towards a market-making role and needs to be considered carefully with government. It needs to be recognised that QE - through its scale and duration - has likely distorted the economy already, and question is one of what sort of distortion best serves society’s needs. The proposal provides a forward signal that the monetary authority is keen to purchase green assets to stimulate the development of the market especially of long dated green bonds and loans. There might also be a tightening of requirements for brown assets, or indeed screening criteria to remove some brown assets altogether from the eligible universe.

Greening the Financial System Climate Bonds Initiative 13 Endnotes 1. Buberl, Thomas, CEO of Axa, “Unsustainable business is un- 22. UK’s Prudential Regulatory Authority issued a supervisory note from thermal coal or base 30 per cent or more of their operations investable and uninsurable business” One Planet Summit – Axa to banks and insurers in April 2019 - https://www.bankofengland. on thermal coal. (4) Recommendations and decisions on exclusion CEO Speech, 12 December 2017, Boulogne-Billancourt, France, co.uk/prudential-regulation/publication/2019/enhancing-banks- of companies based on subsections (2) and (3) above shall not available at : https://www-axa-com.cdn.axa-contento-118412.eu/ and-insurers-approaches-to-managing-the-financial-risks-from- include green bonds issued by the company in question where www-axa-com%2Ff5520897-b5a6-40f3-90bd-d5b1bf7f271b_ climate-change-ss such bonds are recognised through inclusion in specific indices for climatesummit_ceospeech_va.pdf 23. https://www.ifc.org/wps/wcm/connect/5962a2da-1f59- green bonds or are verified by a recognised third party.” Guidelines 2. Carney, Mark, Governor of the bank of England, “Breaking the 4140-a091-12bb7acef40f/SBN_PAPER_G20_02102017. for observation and exclusion from the Government Pension Fund tragedy of the horizon – Climate change and financial stability”, pdf?MOD=AJPERES&CVID=lHehxyG Global, 17 February 2017https://www.regjeringen.no/globalassets/ Lloyd’s City Dinner, 29 September 2015, London, United Kingdom, 24. DNB, An energy transition risk stress test for the financial upload/fin/statens-pensjonsfond/formelt-grunnlag/guidelines-for- available at : https://www.bis.org/review/r151009a.pdf system of the Netherlands, 2018, available at : https://www. observation-and-exclusion-from-the-gpfg---17.2.2017.pdf 3. TCFD, Final Report: Recommendations of the Task Force on dnb.nl/binaries/OS_Transition%20risk%20stress%20test%20 38. Rust, IPE, French central bank formalizes responsible investment Climate-related Financial Disclosures, June 2017 available at: versie_web_tcm46-379397.pdf stance, 4 April 2018, https://www.ipe.com/countries/france/ https://www.fsb-tcfd.org/publications/final-recommendations- 25. DNB, Tine for transition, An exploratory study of the transition french-central-bank-formalises-responsible-investment-stance/ report/ to a carbon-neutral economy, 2016, available at : https://www.dnb. www.ipe.com/countries/france/french-central-bank-formalises- 4. TCFD Status Report, June 2019, available at https://www. nl/en/binaries/tt_tcm47-338545.pdf responsible-investment-stance/10023976.fullarticle fsb-tcfd.org/wp-content/uploads/2019/06/2019-TCFD-Status- 26. UNEP Finance Initiative, Navigating a new climate: assessing 39. Letter from Mario Draghi to Paul Tang MEP, 19 Feb 2019 Report-FINAL-053119.pdf credit risk and opportunity in a changing climate, Part2: Physical- 40. Norges Bank Investment Management, Observation and 5. NGFS, First comprehensive report “A call for action”, April 2019, related risks and opportunities, July 2018, available at: https:// exclusion of companies, assessed on 27/08/2019, https://www. available at : https://www.banque-france.fr/en/financial-stability/ www.unepfi.org/publications/banking-publications/navigating-a- nbim.no/en/the-fund/responsible-investment/exclusion-of- international-role/network-greening-financial-system/press-events new-climate-assessing-credit-risk-and-opportunity-in-a-changing- companies/ 6. IOSCO, Final report, Sustainable finance in emerging markets and climate/ 41. Summary document of Basel III from BIS https://www.bis.org/ the role of securities regulators, June 2019, available at : https:// 27. UNEP Finance Initiative, Navigating a new climate: assessing bcbs/publ/d424_hlsummary.pdf www.iosco.org/news/pdf/IOSCONEWS534.pdf credit risk and opportunity in a changing climate, Part1 : Transition- 42. 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UNEP Inquiry, “Monetary Policy and Sustainability - The Case of bankrolling Europe’s most coal-dependent utilities, 21 May 35. HKMA, 7 May 2019, HKMA introduces key measures on Bangladesh”, 2015 2019, available at: https://beyond-coal.eu/wp-content/ sustainable banking and green finance, https://www.hkma.gov.hk/ 52. LFMEAB, “Bangladesh Bank to set up $200M Green uploads/2019/05/foolsgold_final.pdf eng/key-information/press-releases/2019/20190507-4.shtml transformation fund”, available at : https://lfmeab.org/bangladesh- 16. Influence Map “Who Owns the World’s Fossil Fuels”, 2018, 36. Although HK’s Exchange Fund primarily aims at currency bank-to-set-up-200-m-green-transformation-fund/ Accessed 27/08/2019, available at : https://influencemap.org/ stability while Norwegian SWF mainly deals with the long-term 53. Victor Mendez-Barreira and Karolina Šilytė “The calm before finance-map management of oil revenues, both funds share common features. the storm – the climate change 2019 survey” Central Banking & 17. Technical expert group on sustainable finance, available at Both are managed by their respective central banks. Like the Amundi. 34 our 100 central banks responded. https://ec.europa.eu/info/publications/sustainable-finance- Norwegian SWF, HK’s Exchange fund also deals with country-wide 54. Open letter from Central Bank governors 19 April 2019: https:// technical-expert-group_en long term objectives, as it aims at ‘...maintaining Hong Kong as an www.bankofengland.co.uk/news/2019/april/open-letter-on- 18. High-Level Expert Group on Sustainable Finance, Final Report, international financial centre...’. Like HK’s Exchange fund, Norway’s climate-related-financial-risks available at: https://ec.europa.eu/info/publications/180131- SWF has a currency reserve function for Norway’s Central Bank. 55. We note that the finance sector plays a major role in addressing sustainable-finance-report_en Sources: Hong Kong, Exchange Fund Ordinance (Cap. 66), 1992 money laundering. 19. European Parliament, Amendment 80, Proposal for a regulation ; Norway, Government Petroleum Fund Act (June 22, 1990, No. 56. Volz (2017) “On the role of central banks in enhancing Green Recital 6, Establishment of a framework to facilitate sustainable 36). Douglas Arner and al.,Financial Markets in Hong Kong (2nd finance” UN Environmental Inquiry investment, 28 March 2019, available at: http://www.europarl. Edition), March 2016 ; Backer et al., Sovereign Wealth Fund 57. Monnin, Pierre (2018) “Integrating Climate Risks into Credit europa.eu/doceo/document/TA-8-2019-0325_EN.html?redirect as Regulatory Chameleons: The Norwegian Sovereign Wealth Risk Assessment” Council on Economic Policies 20. page 25 NGFS Call for Action report https://www.banque- Funds and Public Global Governance Through Private Global 58. Dikau, Volz, “Central banking, climate change and green france.fr/sites/default/files/media/2019/04/17/ngfs_first_ Investment (May 4, 2009). Georgetown Journal of International finance”, Asian Development Bank Institute, September comprehensive_report_-_17042019_0.pdf Law, Vol. 41, No. 2, 2009. Available at SSRN: https://ssrn.com/ 2018, available at: https://www.adb.org/sites/default/files/ 21. Villeroy de Galhau, Governor of the Banque de France, “Green abstract=1398835 publication/452676/adbi-wp867.pdf finance – A new Frontier for the 21st Century”, Opening keynote 37. Example of environmental criteria used by the Norwegian SWF: 59. Campiglio Emanuele et al, “Climate change challenges for of the international climate risk conference for supervisors, “(2) Observation or exclusion may be decided for mining central banks and financial regulators” Amsterdam, 6 April 2018, available at : https://www.banque-france. companies and power producers which themselves or through Nature Climate Change, 8 (6). pp. 462-468. ISSN 1758-678X fr/en/intervention/green-finance-new-frontier-21st-century entities they control derive 30 per cent or more of their income

Prashant Vaze, Alan Meng and Diletta Giuliani, Climate Bonds Initiative Climate Bonds Initiative © October 2019 www.climatebonds.net Supported by WWF and SOAS Centre for Sustainable Finance

The authors are grateful for comments and drafting suggestions by Alexander Barkawi, Bob Buhr, Emanuele Campiglio, Sebastien Godinot, Alison Harwood, Kate Levick, Sean Kidney, Lionel Mok, Mathilde Bossut, Gregoire Lunven, Frank Van Gansbeke and Ulrich Volz. The views expressed in this paper are the authors alone and do not necessarily reflect those of the commentators. Disclaimer: The information contained in this communication does not constitute investment advice in any form and the Climate Bonds Initiative is not an investment adviser. Any reference to a financial organisation or investment product is for information purposes only. Links to external websites are for information purposes only. The Climate Bonds Initiative accepts no responsibility for content on external websites. The Climate Bonds Initiative is not endorsing, recommending or advising on the merits or otherwise of any investment or investment product and no information within this communication should be taken as such, nor should any information in this communication be relied upon in making any investment decision. A decision to invest in anything is solely yours. The Climate Bonds Initiative accepts no liability of any kind, for any investment an individual or organisation makes, nor for any investment made by third parties on behalf of an individual or organisation, based in whole or in part on any information contained within this, or any other Climate Bonds Initiative public communication.

Greening the Financial System Climate Bonds Initiative 14